Show notes – Equity Unleashed: Property Planning & Borrowing for Renovations & Wealth Creation (Ep. 230)

Sam’s question

We brought our 4 bed 2 bath mid century family in Greensborough area in mid 2021 for 1 mil approx. Since then the price has fallen then risen, and generic real estate apps pricing it at around the same value.  

The house is older style, has good bones but over time we would love to undertake a moderate renovation. The property is in a good family friendly/school zone, and with the right modifications there is no immediate reasons to move from this property.  

We are getting close to 80%LVR which I understand is a threshold for accessing finance. The original plan was to build our plan out with two more 600k investment properties. 

I would like the property trio to examine this situation, from an accessing equity perspective.  

When and how can you access equity (LVR rate, process and types and loans and additional payments)? 
In the accumulation phase, is there approx best practise advice for when you should consider accessing equity? Eg ASAP or at 65% LVI) 
Pros and Cons on manufacturing equity through upgrades to PPOR versus investing property?  
I am sure there are many other examples and would love the PT’s perspective 

1. When and how can you access equity, let’s start with LVR’s

Most lenders have 3 tiers of LVR:

• Anything up to 80% is the level you can go up to without paying mortgage insurance.

Under this level you generally can access equity with what is known in the lending world as a ‘cash out’ loan.

This is the ideal option, because you are not paying mortgage insurance and you don’t have to provide as much paperwork:

1. If you’re using the money for investment, you don’t need to give the bank details of your investments – eg: what assets you’re going to purchase
2. If you are renovating, you don’t need to provide renovation plans (provided non-structural renovations and don’t need council approval)

• 90% for investment

You can normally go to 90% when funding for an investment. That means you could access up to around an extra 10% of the value of the property to go towards renovations or investing, but you will need to pay mortgage insurance and provide more proof of the purpose of the borrowings.

In your case if you house is worth $1m currently, and your debt is close to 80% or $800, you would be able to pull out $80k to $90k, and assuming you paid mortgage insurance on your initial loan, you will only pay lenders mortgage insurance proportionately on the new lending amount.

• If you renovating the home, you coud actually go right up to 95% and potentially access up to or aorund $150,000 with the similar process if it is a non-structural renovation.

Mortgage strategy and broking has lots of little tips and tricks if you like that can make a big difference that only the most fastidious and dedicated mortgage brokers will think of and in many cases can make a big difference to individual borrowers based on their own unique circumstances.

2. What is the process for accessing equity across the different LVR’s for a standard equity access?

80% – If you are just accessing equity to 80%, this can either be via a variation with the existing lender on the current loan

OR you can set up a new loan with the existing lender

OR you refinancing to another lender.

In your case you probably wouldn’t refinance however if you paid mortgage insurance on the original loan because that would be a significant additional cost verses staying with your existing lender.

You would need a valuation for this and need to provide all the standard supporting documents re proof of income.

At 90% which is the limit for investment, assuming this is accessing equity to purchase an investment property you would get pre-approval for borrowing up to 80% or 90% of the value of the investment property, and set up an equity loan that is separate from your home loan to access the up to 10% equity you have in the home. Until you use that case you should just offset this loan so that you are paying no interest on it.

This is ensures that you have the available cash to pay for the deposit. This is important because a lot of investors don’t realise that if they don’t borrow the cash for the deposit, techinically it isnt tax deductible.

So a lot make the mistake of paying cash for their deposit then later at settlement borrowing the full purchase price plus costs and repaying themselves for the deposit.

Technically, that renders the deposit amount of that loan non-deductible because it was not funded from the loan originally. 

The reason you make the investment loans separate and stand alone from the home loan is so you can maximise your deductions given the home loan is non deductible.

If you just increase the limit on your home loan, you would then have mixed debt and every repayment to that loan would be equally apportioned to home loan and investment loan which you don’t want because the investment loan is effectively cheaper because of the tax deductions, even though the interest rate itself will be more expensive.

Therefore you want all your surplus funds and saving repaying or offsetting the home loan, and to be paying interest only on the investment loan until such time as you have fully paid off your home.

Overall, if it is for investment you want to borrow the full purchase plus costs so your savings arent eroded on the investment and can 100% be utilised for offsetting or paying down your non-deductible debt first.

An example of how this might all look in numbers is $1m x 90% = $900k (existing loan $810k, get $90k to fund shortfall below)

AIP for an investment purchase of $500k x 90% = $450k (need $50k, plus stamps $25k, plus LMI 10k = $85k)

So you have been able to fully fund the purchase plus costs without having to use a dollar of your savings and therefore you are still minimising the amount of interest you pay on your home loan which is the bad debt you want to focus on paying off.

3. What is the process for accessing equity for renovations that require council approval and are above 80%

 The renovations sound reasonably extensive, so they may, or perhaps even likely will require building specs and council approved plans.

In this case the client should know about the scenario where the bank would do a valuation based on the estimated end value. This is known as an ‘as if complete’ valuation – whereby the assessed land and improvement value (from the build contract) is used to determine the value of the property, once the construction is finished.

Therefore they could extend the LVR up to as high as 95% with most lenders of the end valuation as opposed to the current valuation factoring in the renovations given this is the family home.

Given they are currently almost at 80% this could allow them to fully fund the renovations without having to contribute any more cash.

Example 1

Assume renovations are $200k and the valuation based on ‘as if complete’ is  $1,200,000.

This means they could borrow up to $960k at 80% or an extra $160k which would leave them needing to find $40k which they may not have.

In example 2 If they borrowed the full $200,000 the loan amount the loan would be around $1,000,000 and that would be a LVR of 83.33% which would mean some mortgage insurance is payable, but with the LVR being close to 80% because of the ‘as if’ complete, the LMI payable would not be as high as it otherwise could have been.

For example 3 we will do a scenario whereby the valuation doesn’t come in at the current value PLUS the construction cost which does happen reasonably often on ‘as if complete’ valuations. Especially with a home renovation. We have seen the “improvement value” (which is the building contract price in this case) returned lower than the cost of the building contract. A lower than expected ‘as if’ complete value, will eventuate in either a higher LVR and LMI premium.

However, even if the valuation was less than the current value plus the improvements which is quite possible, they still have plenty of room to move with the valuation and the LVR and so this should be very achievable. 

Lets say the ‘as if complete’ valuation came in at lets say $1,150,000 instead of $1.2m and the current loan is lets says $815,000, they would end up with a loan of $1,015,000. In this possible worst case scenario the LVR is still only 88%.

Assuming they paid LMI on the current loan which is likely given they mentioned that they are still above 80%, it is probable that they borrowed around 90-95% as it is the most common approach when borrowing above 80% for a first home, the LMI payable shouldn’t be overly extensive.

As touched on, in scenario where you need to pay LMI, and you already paid it once, there is a real benefit to stay with the same lender as the LMI will only be on the increase V refinancing.

Most lenders factor in the LMI premium originally paid as a credit. So they will calculate the full LMI premium payable now on the as if complete val and current LVR and then deduct the original LMI premium paid, to determine the LMI payable. (the current loan balance and loan limit won’t have any bearing)

Servicing might be the only issue and refinancing is still a possibility but based on the question, it seems as though they feel like the problem is equity, not borrowing capacity. A Preliminary Assessment of borrowing capacity would also be required to ensure they can service the increased loan amount.

4. What type of loan and repayment types can you have when accessing equity or completing a home renovation?

Cash out

This is a great option for renovations or small constructions that don’t require council approval or for financing the 20% plus costs on an investment.

The benefit is that you don’t have to provide as much paperwork:

1. If you’re using the money for investment, you don’t need to give the bank details of your investments – eg: what assets you’re going to purchase
2. If you are renovating, you don’t need to provide renovation plans (provided non-structural renovations)

You can take out the loan and the money just sits there until you need to use it and you would offset it so you don’t pay interest until you need it.

HOWEVER, the majority of lenders have restrictions on cash out amounts up to 80% – some policies include:

1. Max $50K with no defined purpose. (eg you could state purpose as personal investment)
2. Others are $100K with no defined purpose.
3. Whereas some are more flexible with their cash out policy at around $300K-$350K, if you state the purpose the funds will be used for.
4. One or two lenders has very flexible policy with unlimited cash out up to 80% LVR for ‘personal investment’ purposes.

At times if you are trying to get Cash out for renovations that don’t require council approval, you will need to have a clear purpose for the usage of funds. Some lenders might ask for a breakdown such as renovation of bathroom, Kitchen, Garage door and the amount for each item.

Some second-tier lenders will allow above 80% cashout, but this would require you to pay mortgage insurance.

In terms of Repayment type for cash outs

• Can be IO for investment, but if you are borrowing for the home up to 95% may need or be best to pay P&I.
• Additional repayments can also be done. 

For Progressive drawdown Construction loans –

• In the majority of cases, if the renovations are extensive such as structural in nature, require council approved plans and have a higher expense involved, there often isn’t the equity available in the property for a cash out loan so a construction loan will need to be sought.
• This requires a contract to be signed with a registered builder – plans and specs along with an ‘as if complete’ valuation.
  • So, you have to have the paperwork and council approvals ready to go before the bank will approve the funds.
• Also, within the build contract will be a schedule for the various stages of the build and invoice amount to match each stage.
• There are usually 5 stages.
• As each stage of the construction/renovation is reached, the builder will invoice for the specified amount, the bank then sends a valuer to inspect the works done – to ensure works complete are according to the contract – before they to approve releasing the funds directly to the builder – this is called progressive drawdown, as the loan funds are not released all at once, but as each invoice is issued.
• These loans are much less flexibile compared with a cash out loan where you get the lump sum available to you up front to do with what you like with it and you therefore have more flexibility to change your plans as you go, extend your budget, and it doesn’t require the banks approval to vary the build contract.

Repayments for construction loans

• During the construction as the loan is being progressively drawn, repayments are generally interest only
  • After construction is complete, the repayments can be either interest only or P&I depending on the LVR if it is under 80% and the purpose (investment or owner occupier)
• It will be a variable rate during the drawdown phase, and can then be a normal variable or fixed rate loan or a split afterwards.

A construction loan – with registered builder contract, plans and specs, along with ‘as if complete valuation’ would most likely be required in this case given they would be above the 80% threshold.

5. In the accumulation phase, is there approximate best practice advice for when you should consider accessing equity?

Whenever you feel ready. If we are talking about building an investment property portfolio it really depends how aggressive you want to be.

If your risk profile allows you to take greater risks then you might take this step now when you are around 90% LVR and borrow up to 90% on the home and the next investment.

Alternatively, if you didn’t want to pay LMI against the home, you might wait until you are around 65-70% LVR on the home, pull out equity and borrow 90% against the investment knowing that you can claim the LMI premium as a deduction.

Otherwise, you might be waiting until you are 60-65% and only have to borrow 80% against the home and the investment, but that means you need to wait longer, and therefore have less years of asset accumulation and the power of compound growth working for you.

Ultimately, there are always two key factors at play, equity and your cash flow or affordability from a borrowing perspective and the preferred LVR really comes down to your capacity to take on risk.

6. What are some pros and cons of manufacturing equity through upgrades to principal place of residence vs investing in property?

Through Upgrades to PPOR (Principal Place of Residence): 

Pros:

• Increased home value,
• improved quality of life,
• potential for higher resale value. 

Cons:

• potential for overcapitalization and value increase is less than cost of renovations
• short-term rental costs during renos. 
• Chew up equity that could be used towards investing
• Family disruptions
• Cost blows out/unexpected additional costs

Through Investment Properties: 

Pros:

• Increased passive income,
• potential for higher ROI via manufacturing equity. 

Cons:

• Risk of property market downturn,
• Over capitilasion
• property management requirements. 
• Cost blow outs